1. Fixed investment, uncertainty and
financial market volatility in Japan
Luke Meehan, PhD Candidate in Economic Policy
AJBCC Scholar @ AJRC
Crawford School of Public Policy
2. 2
Outline
• Aim
• Why is investment interesting?
• Why may uncertainty be important?
• A simple model
• Which variables and data sources matter?
• What empiric method is appropriate?
• Simulation results
• Conclusion
3. Aim
To consider the theory that “uncertainty shocks”
embody variations in the distribution of expected returns
to capital goods investment
By evaluating the stochastic impact of uncertainty on
Japanese private fixed investment patterns
And so understand the causes of Japanese private
fixed investment variation during the ‘Lost Decade(s)’.
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4. Why is investment interesting?
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13.55
13.65
13.75
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14.25
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1987.2
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Yen/USD
Machinery Investment
Horioka (2006) found that the
proximate cause of Japan’s Lost
Decade were falls in inventory and
fixed investment, particularly private
fixed investment.
This sits well with most modern macro
models, in which investment is a key
driver of cycles and trends.
The question about what caused these
investment falls remains open, with
financing constraints, long-term TFP /
demographic trends and policy
uncertainty all found in the literature.
But neither supply nor demand factors
seem able to provide the necessary
richness of relationship. (Kasahara,
Sawada, Suzuki 2012) -4.00
-3.00
-2.00
-1.00
0.00
1.00
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Mfn Labor Costs, %
Real interest rates
6. …with uncertainty
• Uncertainty might be important for investment if it is related the anticipated
returns on irreversible investment under uncertainty.
– As per a theory first sighted in Nick Bloom’s IMF presentation, but probably existing elsewhere
• Under this concept, uncertainty is the anticipated shape of the return to
investment distribution. This can impact investment decisions by increasing the
‘real option’ value of waiting as well as via manager risk-aversion.
• Note, volatility is the realisation of unanticipated uncertainty.
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7. Variables and data, (1)
Wanted: E(R), Var(E(R)), E(Costs)
– Also important to distinguish between anticipated and
unanticipated variance
E(R), Var(E(R)), E(Costs) are unobservable at a macro level
– and imperfectly observable at the micro
And so we need to use a series of instruments which are:
– available to decision-makers
– theoretically-sound
– useful to the wider literature
Period: 1987Q2: 2011Q1, quarterly
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8. Variables and data, (2)
Private fixed investment: Property, Plant, Equipment.
• property likely to be a bit odd post-bubble, so want plant and equipment
• use ESRI’s ‘Private machinery orders’ data, seasonally adjusted
E(Costs): Labour and Capital
• whilst both are relatively stable, real interest rates show more variation
• use BoJ’s discount rate, turned into real rate with CPI from MIAC
E(R): the current value of mean anticipated future returns
• this sounds usefully similar to definition of fundamental value of a
financial asset, so Nikkei 225 Index used
Var(E(R): the spread and skew of the returns distribution curve
• significant behavioural literature showing as distribution of potential
outcomes increases, so does the degree to which individuals are
decreasingly confident in making a decision entailing risk
• use BoJ’s ‘Tankan’ business confidence survey, seasonally adjusted
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11. Results 1 – investment impulses
• In the short term, machinery exhibits
positive autocorrelation, typically
becoming neutral after 8-quarters.
• Increases in machinery purchases
consistently and constantly lower
Tankan indications.
• Real interest rate responses appear
consistent and negative at 4-
quarters, becoming volatile and
positive in 8-12 quarters.
• The Nikkei Index responds
consistently positively at 4- quarters,
becoming volatile and generally
positive in 8-12 quarters.
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12. Results 2 – real interest impulses
• Machinery purchases are
relatively unresponsive at early
time periods, but in later periods a
short-term positive response is
observable. This response decays
to a slight negative response at
the 1 year point.
• Real interest rate autocorrelation
appears to decay over 3 years.
• Throughout the estimation period,
real interest rates spikes increase
business confidence in the short-
term, but with varying results in
the medium-term.
• The Nikkei 225 Index typically
exhibits at negative short- and
medium-term response to real
interest rate increases
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13. Results 3 – Tankan impulses
• Machinery purchases exhibit
significant ‘noise’ in response to
Tankan variations.
• Tankan autocorrelation is does
not appear to fully decay over
the 3-year period
• The Nikkei relation is generally
neutral, but becomes strongly
positive during and after the
Asian Financial Crisis and the
Global Financial Crisis
• The real rate of interest falls in
response to Tankan spikes, but
this response typically decays
over 3 years
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14. Results 4 – Nikkei impulses
• Machinery purchases respond
positively to Nikkei innovations
over the 1- and 2-year horizon,
typically decaying by 3 years.
• The Tankan reacts positively over
1- and 2-years to the Nikkei. The 3-
year points are less clear, but
appear to inversely reflect business
cycle trends.
• The real interest rate is neutral to
slightly negative in response, a
consistent relation across the
period.
• The Nikkei’s level response
appears consistent and positive
after 12 quarters.
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17. Conclusion
• This paper sought to understand the relationship between
investment, uncertainty and Japan’s Lost Decade.
• The simulations present evidence of a relationship between
uncertainty and investment that of important magnitude and
duration.
• The direction of investment responses to uncertainty shocks
are as anticipated in the model
• The results add credence to the theory that variations in
uncertainty alter the shape of the distribution of expected
returns to investment and are therefore important business
cycle events.
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